COLOMBO, Dec 12 (Reuters) - Sri Lanka's central bank
surprised markets on Wednesday by cutting key monetary policy
rates for the first time in nearly two years in order to boost
economic growth as inflation pressures were expected to ease.

The bank reduced the repurchase rate and the reverse
repurchase rate by 25 basis points to 7.50 percent and 9.50
percent respectively, lowering them from three-year highs.

A Reuters poll of 13 analysts had expected that both rates
would remain unchanged.

The central bank had kept rates steady since April,
following two hikes made earlier in the year when Sri Lanka also
adopted a flexible exchange rate policy as part of a strategy to
counter a balance-of-payments deficit.

Central Bank Governor Ajith Nivard Cabraal said the bank
originally expected to make cuts from January, but reduced
inflationary pressures had prompted the bank to move more
quickly to a pro-growth stance so that people could make
spending and investment plans based on lower rates.

"The demand-driven inflation is subdued," Cabraal told
Reuters. "There is no need to prolong it. It's an impetus now
and the people can get ready with the plans ahead of the next
year."

Headline inflation is expected to moderate by the second
quarter of 2013 after hovering around the current level due to
supply side shocks, the central bank said in a statement.

Annual inflation has risen due to a supply shortage mainly
in foods, and notched three-month high of 9.5 percent in
November, compared with 8.9 percent in October. That is still
below the 42-month high of 9.8 percent struck in July due to an
extended drought that hit the farm sector during the preceding
months.

"You don't deal with such inflation through interest rates
or credit curtailment. So it made a lot of sense for us to take
the decision," Cabraal said. "The government's tightening of the
fiscal deficit also has helped towards inflation control."

Sri Lanka last month said it will achieve a fiscal deficit
of 6.2 percent of gross domestic product (GDP) this year, a
target agreed with the International Monetary Fund under a $2.6
billion loan, but the central bank wants to help reverse a slide
in the growth rate.

The central bank has aimed for 7.5 percent growth next year,
while the government aims to bring the budget deficit down to a
35-year low of 5.8 percent Of GDP.

Sri Lanka's GDP grew at a record 8.3 percent in 2011, and
the central bank was forced to lower its growth forecast twice
this year, having started with a forecast of 8 percent growth
for 2012.

The bank also announced that a rule restrcting commercial
banks credit annual growth to 18 percent, that was brought in
last year, would be ditched at the end of this month.

The bank said it expected the private sector credit growth
to have decelerated to around 19 percent year-on-year from a
near 16-year high of 35 percent in March.

Samatnha Amarasinghe, an economist with Standard Chartered
Bank in Colombo, expected further rate cuts, but with inflation
still at high levels she expected the central bank to wait at
least a few months.

"We may not see cuts in the first quarter again, but we
expect another 50 basis points next year," she said.

The rate cut had little impact on the share market, while
the rupee currency was barely changed at 128.75/80 per
dollar. Just a tad firmer than Tuesday's close of 128.80/90.